Money
Issue No. 10 - April/May 2003
Effect of a Stronger Dollar
by Tony Catt
Over the past 12-18 months, the Australian equity market has been through a number of episodes where the consequences of a rising A$ have been mooted as a stock selection criterion, only to be forgotten once more as the currency rally has proven short-lived. Since August 2002, the A$ has appreciated close to 10% against the US$ and once again we find ourselves discussing the potential implication of currency moves on stock selection.
Our overriding thoughts on currency impacts are that they are extremely complex and it is often dangerous to oversimplify. The impact of currency movements on stock selection is not straightforward and will be affected by a multitude of factors including the macro drivers behind the appreciating currency, the denomination of revenue and costs, pricing power, the currency denomination of debt, and the level of hedging.
Importantly, we believe earnings forecasts already incorporate a degree of the increase in the A$. On this basis, the immediate risk to near-term forecast earnings may be relatively small (either up or down). Similarly, the prospect of stronger global growth and commodity price upside may also help to mitigate adverse currency impacts. However, our view is that the trigger level for rising earnings vulnerability is likely to be around the US$0.60 level.
Our key message is that investors should remain wary of the detrimental impacts of a strengthening currency, but should treat the A$ as a secondary consideration to primary issues of operating performance and valuation.
What's driving the appreciation?
I view three key factors to the recent strength in the A$:
- increasing conviction in a global economic recovery;
- declining risk aversion and an increase focus on peripheral based currencies;
- $US weakness
These factors are all intermittently linked and feed off each other. More importantly, they may also work to offset or in some cases, reinforce the detrime...
